Failure to raise the [debt] limit would precipitate a default by the United States.

In context, it's clear that by "the United States," Geithner really means "the United States government."

But would it necessarily trigger a default? Newly elected U.S. Senator Pat Toomey wrote a January 19 Wall Street Journalop/ed in which he pointed out that the amount of money required to continue to make payments on all the U.S. government debt is a small fraction of the amount of revenue the U.S. government raises. Toomey wrote:

Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?

Treasury official Neal Wolin responded to the Toomey idea of prioritizing payments on the national debt as follows:

While well-intentioned, this idea is unworkable. It would not actually prevent default, since it would seek to protect only principal and interest payments, and not other legal obligations of the U.S., from non-payment. Adopting a policy that payments to investors should take precedence over other U.S. legal obligations would merely be default by another name, since the world would recognize it as a failure by the U.S. to stand behind its commitments.

Wait a minute. If you succeed in making principal and interest payments, don't you avoid default? Wolin is equivocating on the term "legal obligations." As I understand the term "obligation," the government is not obligated to pay for goods and services when it doesn't get those goods and services. So the government could cut the goods and services it buys without violating any obligations.

Toomey wrote a letter to Geithner on February 2 taking on Wolin's sloppy reasoning. Geithner replied on February 3 and gave an analogy. Geithner wrote:

A homeowner could decide to "prioritize" and continue paying monthly mortgage payments, while opting to cease paying other obligations, such as car payments, insurance premiums, student loan and credit card payments, utilities, and so forth. Although the mortgage would be paid, the damage to the homeowner's creditworthiness would be severe.

(I couldn't find the whole letter on the web; I got it from Senator Toomey's office.)

Again, wait a minute. Notice Geithner's mixing of debt obligations and other expenditures. On car payments and student loan and credit card payments, Geithner is right. But on insurance premiums and utility payments, he's wrong. Those are not typically debt obligations. Geithner is effectively saying that if the government wants to spend x and has only enough money to spend 0.67x, then not spending on the other 0.33x is a failure to keep an obligation. In a political sense, that might be: the government has made a lot of spending promises to a lot of people. But in an economic sense, it's not. On the narrow issue of whether failure to raise the debt limit would necessarily mean U.S. government default on its debt, Toomey is right and Geithner is wrong.

Comments and Sharing

It's a good point. A de jure default isn't very plausible if we prioritize debt payments. Losing the confidence of the bond markets, on the other hand . . .

> Wolin is equivocating on the term "legal obligations."

Sure. I think the idea he's getting at is, if we made (say) cuts to defense spending, that would send a message to the rest of the world that we were scared of our high debt levels, and if we are scared, then certainly everyone else should be scared, and it's "like" a default.

So basically, the more indebted we are, the more we should act like we don't give a damn about what we're spending, and our confident and optimistic attitude will reassure everyone that we're still credit worthy. Ridiculous as it is, I think this plan might actually work in the short run, but it ain't gonna work forever.

Also, if our benevolent leaders do raise the debt ceiling, can we get someone to sponsor a bill to abolish the damn thing? I mean really, it's just embarrassing to have a debt ceiling whose only purpose is to periodically be raised whenever we start to get close to it.

I'm still confused as to what these 'other legal obligations', that aren't debt, are supposed to be. And, why prioritizing P&I payments (and tightening the belt in other ways if necessary) is supposed to scare, rather than encourage, bondholders. Is this opposite day?

So basically, the more indebted we are, the more we should act like we don't give a damn about what we're spending, and our confident and optimistic attitude will reassure everyone that we're still credit worthy.

Isn't the inverse at least as likely?

That is, if the US does not raise its debt ceiling, doesn't that send a message to the lenders of the world that the US is finally taking its debt seriously and make us appear more credit worthy?

I think you are kind of picking the fly poop out of the pepper here. He was just trying to make the point that a failure by congress to raise the limit would be negative signaling to the world debt markets.

Thank you so much for such an excellent post....and for calling out the Treasury Secretary on too much Blarney. Specifically, that the Treasury Secretary is lumping all gov't expenditures into the pot of "debt obligations". I really appreciate you sticking your neck out.

I also find it a bit insulting that Mr. Geithner expects us to swallow his homeowner analogy. I think I have even greater disdain with this analogy than you do. In addition to mixing debt obligations with other legal obligations, the Secretary seems to ignore the distinction between legal obligations and discretionary expenditures. To use the same analogy, what about the homeowners expenditures for vacation travel and dining out. Those are expenditures also, but his credit rating would be fine if he stopped paying them. This brings up a deep question regarding exactly which gov't expenditures are true legal obligations, and which are discretionary. Especially since the gov't can change the rules. For example, if ObamaCare was to be rescinded in it's entirety, I don't think anyone would accuse the gov't of defaulting on its legal obligations.

I think if you look at the common law of contracts it is pretty clear that if there is a 'contract' and you violate one of the terms of the contract the counterparty is entitled to damages. These terms are debt and they can be discharged through performance or payment of damages.

Something similar applies for other laws of obligations (e.g. torts). That there is in fact a contract, depends on which school of thought you subscribe too (Offer & acceptance orthodoxy or perhaps Atiyah's suggested 'reliance'). I'd argue that there is based on outward appearances it seems pretty clear.

The main difficulty is that there is no court to enforce such a contract.

The argument then basically boils down too: 'we'll do whathever we want cause there is no one stopping us.'

The reason why this argument should appeal to people on the right is that the common law, it used to be said, is revealed by reason in the same way that natural law is.

Of course, in the technical sense we only care about default because of what happens to interest rates after we default.
Put another way, today's lenders don't care whether we defaulted yesterday, as long as we pay off the loan they make today. Prior defaults are an important indicator of likelihood to pay, but not the only one and are not absolute.
I think investors would command a much higher interest rate even if if we remained current on today's debts if we failed to operate the government we have constructed through 200+ years of consensus.
Lenders would also have to wonder whether failing to raise the debt ceiling was the first in a series of increasingly draconian actions that would eventually result in default. You tend to think like that when you are lending over 30 years.
In that sense, failing to raise the debt ceiling would likely hurt investor confidence and raise interest rates, perhaps significantly.
The result would be a de facto default, because the important feature - borrowing rates - would behave the same as if default had taken place.

If indeed there is a 'de facto default' (=higher interest rates) because the US doesn't do as much discretionary spending, or something, wouldn't this mean we could buy back our own debt more cheaply? Then we'd have less debt oustanding and less chance of default; also, rates would be pushed back down.

Even if you immediately ceased government spending above the 67% tax revenue level, there's still a possibility of reaching the debt limit insofar as refunds are only recorded as a Treasury liability when individual tax returns are filed.

Moreover, retirement benefits are only borrowed for when the expense is incurred. You may think the benefits are unwise or undeserved, but it is a legal contract.

@Lance,
If by "retirement benefits" you mean Social Security, then your statement is false. The Supreme Court made it clear in its 1960 Flemming v. Nestor decision that there is no contract. SS is simply a tax and subsidy scheme.

Even if a failure to, say, make Social Security payments wouldn't necessarily be a default on technical grounds, the probability that the market would treat it as such seems high. Especially since the Republican House majority has no more of a workable plan to eliminate the current deficit than anyone else.

Lance, it may be the case for those already retired, but it is not the case for those still working. We could change the terms of their pensions now, for benefits to be accrued in the future (benefits accrued in the past may be locked in contractually, I will give you that).

All contract the federal goverment has the option to cancel them at their lesure. However, they have to pay cancalation fees. So Tommeny is not tollay right in it is only debt obligations.

The U.S. Goverment has contracts which it is legal obligated to or has to pay a fee to get out of them. Also I would not take grants to states and others in the same light. The U.S. goverment coudl stop 100% of all fund transfers to states. It is not like the state has a contract with the federal goverment is is providing the federal goverment services for the money.

However, Geithner is treating investor confendence has a proven messurable fact for a given event which is dishonest.

My question is since all speding bills are laws is congress violating the law by not fudning and paying for the law in a timley manner because it fails to act and increase the debt limit? Of course it is a mute point if congress cuts spending to revenue levels.

Overall though Geithner is being dishonest but Toomey is making it seem a more simple than it really is. However, I am with Tommey.

Social Security is a law.
Therefore Social Security payments are a legal obligation.
QED.

Now, congress is certainly capable of changing the SS law and removing these payments. But failing to raise the debt limit doesn't do that. It doesn't remove any of the other payments that congress has dictated via law (aka "legal obligations".) It simply forces the executive to start picking and choosing what laws it's going to enforce.

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